Global financial flows, aid and development

This paper – written by Eurodad for CONCORD’s Aidwatch coalition – sets out all the financial resources potentially available for development. It examines their key characteristics and discusses their poverty and sustainable development impacts, as well as the implications for aid.

This discussion could not come at a more important time. Aid is under severe pressure as donors seek to cut budgets and to reorient aid so that direct ‘results’ are more clearly attributable to it. Recent initiatives at European and donor level have sought to change the focus of the aid debate towards stimulating the private sector. This includes emphasising the role of private flows, particularly foreign investment. At the same time, the development community is gearing up to decide what targets should replace the Millennium Development Goals. Incorporating financing into this framework will be vitally important.

These changes in the aid debate are taking place against the backdrop of a greatly increased focus on other financial flows – including illicit capital flight – as governments seek to plug leaks in their revenues. They are also increasingly aware that the ongoing economic and financial crisis has demonstrated how fragile – yet how important – finance flows, financial institutions and financial regulation are.

The key findings of this analysis are:

Scale and trends

Domestic resources are far larger than other financial resources, and have been growing as a share of GDP over the last decade.

Overall, outflows are significantly larger than inflows, mainly caused by illicit capital flight and reserve accumulation: both issues that are intimately linked to global policy failings.

The picture varies across countries, and low-income and vulnerable countries tend to be far more affected by external resources than other countries.

Volatility and risk

Volatility and predictability of external finance is a major issue, especially for low-income countries, where it is equivalent to a major share of GDP.

Private flows, in particular portfolio equity and short-term finance, are particularly volatile and can be incredibly destabilising.

Public sources of finance are much more predictable and stable, particularly domestic taxation. If aid could be made more predictable it would make a major difference to its value as a financial resource for developing countries.

The current structure of borrowing and lending imposes significant costs on developing countries.

Distribution

The poorest countries have very low levels of financial resources per capita. This is true for all types of resources, including domestic resources.

Public resources have the potential to target the poorest and most vulnerable in society in a way that private flows cannot. Aid is particularly important in low-income countries where it averages around one tenth of GDP.

Accountability and transparency

All of the resources discussed would benefit from significant improvements in their accountability and transparency, but higher standards are expected of public resources.

Impacts on domestic politics

Domestic political impacts of resource flows can be extremely important for poverty reduction and sustainable development. For example, the conditionalities attached to lending by international finance institutions (IFIs) have proved highly controversial.

Other theories are also important, such as the resource curse (where the economy and governance are undermined by dependence on a primary commodity) and the social contract (where the act of having to depend on citizens for revenue forces governments to become more accountable).

The process of international economic liberalisation over recent decades, and the growth in the offshore economy, have provided incentives for governments to engage in a ‘race to the bottom’ on taxation and on standards expected of companies.

Contributions to sustainable development

The impacts of different resources on poverty reduction depend on the overall macroeconomic, political and environmental environment in each individual country.

In the sphere of public goods – including basic services, the environment, natural resources and security – there is a greater demand for public sources of finance.

In the sphere of productive development, the dominant neoliberal paradigm is giving way to recognition that successful economies have used industrial strategies to move up the value chain, particularly through promoting manufacturing, which has required strong state intervention.

The paper draws six broad conclusions:

Civil society organisations (CSOs) have been right to focus their campaigning energy on a broad set of development finance reforms and structural change.

A traditional focus on aid as a mechanism to provide public goods remains important.

Growing demands for public finance to protect international public goods suggest we will need to mobilise other financing sources.

Aid should make sure it supports domestic resource mobilisation.

The push to use aid to ‘leverage’ private finance is built on shaky assumptions.

We need to be particularly aware of aid’s potential macroeconomic impact in low-income countries, including by improving predictability, and supporting local procurement.